Bitcoin Primer — ELI5
My aim here is to help novices (like myself to be honest) gain a fundamental understanding of what bitcoin is and what the prospect for use is.
What is Bitcoin?
Imagine you have $10 and want to buy a shirt, you walk into a store and hand over the ten dollar bill and get your shirt. You can do this for all the different transactions in your life: paying rent, buying petrol, buying a laptop etc. But this doesn’t scale: you can’t pay for things over the internet, you need to carry a lot of cash around, you need to keep track of your cash and expenses yourself etc. Walks in debit cards, credit cards, MPesa etc: they solve this problem. But then the companies behind the scene charge for this service and control significantly what can be done or not done: they might ask for your billing address, they might charge a 2% fee for transactions, they might report to the government and force you to file taxes etc. Can we get rid of all of that? Can individuals and the public have way more control over their money and how they transact with it? Yes, we get rid of it via bitcoin.
The basic sense of bitcoin is as follows. Imagine we do a census of everyone in the country and track how much they have then we give each of them a sheet of paper with a record of this and ask them to keep track of any transaction that goes on in the country. So if Buhari sends money to Osibanjo, he announces it on TV and everyone in the country records it on their sheets of paper, and if my dad sends me money, he announces it on TV and everyone records it on their respective sheets of paper. That way, everyone knows who sends whom money and how much everyone else has left. There is no need for banks to keep track of balances or for anyone to hold physical cash since what matters is that everyone in the system has a record of the wealth of everyone else and can send and update once requested. What if some people try to lie or cheat? We don’t bother: we maintain the legitimate record as whatever 51% of people say. It’s a financial democracy.
I have just explained what a blockchain is. It’s a decentralized public ledger (meaning no central record keeper: records are kept and scattered amongst everyone in the system) that bitcoin uses to keep track of transactions and wealth.
To get a bit more literal on how things are under the hood:
The sheets of paper everyone has are effectively computers/software running on a computer. Whenever a transaction happens, it is sent to a queue and after “a while in the queue” (about 10 minutes), all the computers in the country (read: network) record the transactions and update their balances. The Bitcoin system is the network of all computers that maintain their respective similar ledgers and communicate with each other, recording and updating transactions.
At this point, I need to clarify that per original analogy, we might not know that Buhari is the one sending to Osibanjo. Rather, all we know is that there is a wallet address sending to another. So effectively, everyone with money is represented as a wallet (or wallets) and they can send money to other wallets whose owners we might not know: all they need to do is announce the transfer in public.
But do you need to have a computer that records all the transactions for you to participate? Surely this would require a lot of storage, internet access etc (current ledger size i.e record of all historical transactions is about 80 GB). Thankfully, no. You can still use bitcoin from your phone to make transactions easily. You’re just effectively agreeing that whatever 51% of computers/record keepers in the system define as the current state of the ledger is what it is. So you can send bitcoins from your own wallet to your mum’s wallet, report it to the network of computers and they will do the verification and updating.
So what is the reward of anyone who leaves their computer in the system? Glad you asked. Whenever transactions are made, they spend “a while in the queue”, and are aggregated in what is known as a block. However before anyone’s computer can add a block (a list of currently processing transactions) to their ledger, the computer needs to solve a very, very complicated math problem that belongs to a category of math problems that are “very difficult to solve but easy to check that the answer is correct”. All the computers in the network are racing to solve this problem and once one solves it, it broadcasts the answer and the rest verify that it is correct. The problems issued take about 10 minutes for computers to solve but might take less than 0.001 seconds to verify as correct or incorrect. Anyone who solves this problem is given free bitcoins (as at today, 12.5 bitcoins) and that block is added to the ledger by everyone. People with computers in the network, helping to record transactions and hopefully get free bitcoins are called miners and their solution to problems presented is called a proof-of-work.
Since what happens in the proof-of-work (i.e mining) step is that computers do trial and error to find a solution i.e. they test if 1 is correct solution, check if 2 is correct, then 3 etc, people (miners) then pool their computers together in order to increase their chances of winning. So instead of Taiwo testing for 1, 2, 3 while Kehinde does same, Taiwo would check 1–100 and Kehinde would check 101–200 and they keep going till they have an answer and share the bitcoin reward. Currently, mining pools are complex systems set up among thousands of computers who share rewards. Special computers (with advanced ASICs (application-specific integrated circuit): ASICs are special processing units — think of the components that make up a CPU) are built and used to increase the speed of solving the problems. However, every 14 days or so, the bitcoin system adjusts the complexity of the problem it issues to ensure the average time of solving is still about 10 minutes.
21 million coins: there are currently about 17 million coins in total with about 12.5 added every 10 minutes (mining is the only way coins are added). The reward for mining is halved every 4 years or thereabout: the next reward cycle will change to 6.25 every 10 minutes for 4 years etc till we reach 21 million total coins then it will be 0 rewards, in about 2140. At that point, reward for mining is expected to be transaction fees (far less than the 2% currently charged by VISA) for select transactions.
What if someone steals my coin/wallet password? sorry, no charge backs and reports for frauds. The bitcoin system cannot and does not reverse transactions. You are responsible for maintain the safety and security of your wallet information so you aren’t duped. There are some private conceptions of fraud insurance but they aren’t natively baked into the system.
The community hope is that people move away from fiat money and start using bitcoin. To be honest, the faith is far more in the concept of blockchain than this (this refers to bitcoin) specific implementation and use of the blockchain. Most people who aren’t hardcore bitcoin wankers do not think bitcoin is the future of payments. They think the blockchain is. But bitcoin is at least a major step towards the emergence of that future. It has a lot going for it that will keep it dominant and important as we approach a decentralized money world.
- it’s the goto for newcomers coming into cryptocurrency
- it’s the goto way to buy other up and coming cryptocurrencies. You go from Dollar/Pounds/Naira to Bitcoin to <insert other cryptocurrency>)
- it has a lot if investments and backers. There is research and development, developer efforts, investors, strong marketcap, opportunity for traditional trading like shorting, chance of ETFs (major announcement of first bitcoin ETF potentially on March 11) etc
- it is stable. It has been tested and feels trusted after being in the mainstream for about 4 years now.
In summary, bitcoin is a cryptocurrency that exists as a network of computers that keep a historical record of transactions and enable users to transfer funds to each other over vast geographical distances without the need for transaction fees and with the possibility for anonymity. Computers that participate in maintaining the ledger stand a chance of earning free bitcoins as their reward.
I am strongly opposed to primary conceptions of Bitcoin as a form of investment. I think it defeats the purpose and does not promote the creation of the organic network effect that is so important to the platform. Far more important in my opinion is the realization of the value of bitcoin for anonymous stores of wealth, combating Central Bank monetary policies that wreck havoc in economies (I will write a post on how people are using bitcoin in Venezuela, Brazil, India etc), transaction-fee-free transactions that lead to cheaper products and services etc. I want a world in which it is far easier and faster for parents in Lagos to comfortably send their kids in Chicago meagre sums as pocket money and they gets delivered almost instantaneously without exorbitant financial charges; a world in which electronic store merchants with low profit margins aren’t strangled by credit card processing fees, a system in which governments around the world don’t keep printing arbitrary currency notes that lead to inflation and hyperinflation, a world in which exchange rates aren’t artificially set for political purposes. That world knocks. It knocks hard.
Also, I am not yet focusing on talking about options for purchasing bitcoin since it’s important to understand it, buy into the vision and the value, spread the education and awareness, then find use cases for it: bitcoin’s intrinsic value as money rather than an investment tool.
It’s the libertarian’s wet dream. I hope you’ve learnt something.
If you have more questions about the technicalities of the implementation of bitcoin, feel free to ask below and I will be glad to answer or find you an answer. If you see an error in any explanation above, please feel free to mention (within reasonable approximation of analogies).